Inflation is Primarily a Product of too Much Money Chasing too Few Goods & Services
What to expect for the remainder of 2022
There are 4 components that impact inflation:
- Supply factors – supply bottlenecks, stimulus money, and loose monetary policy.
- Demand factors – consumer, corporate & government spending on goods & services.
- US Dollar – a strong dollar will give us some greater purchasing power in the global markets and will pull down import prices.
- Money Supply Factors – Growing the money supply at greater velocity than is needed will provide the fuel for inflation.
Since the onset of the global pandemic, the inflationary environment has been inflamed by supply factor-related problems with ports, international manufacturing shutdowns, and global shipping as primary challenges. These have been major factors in supply chains and inventory management. For example, auto manufacturers are still hampered with ready access to necessary components.
The good news is that as of the last inflation report, the supply factor contribution to inflation fell, and demand factor-driven contributions to inflation became more of a dominant factor.
This fits perfectly into the script for the Federal Reserve. Their monetary policy tools (like raising interest rates), are blunt, but are suited for tamping down aggregate demand, and as Chair Powell himself warned, “Our tools don’t work on supply factor problems.” For example, by raising interest rates the Federal Reserve has caused mortgage rates to increase. This in turn had affected the demand for real estate reducing the demand for homes.
How the Federal Reserve raising interest rates effects inflation
Therefore rate hikes help to fight inflation only to the extent they slow the rate of economic growth (at least temporarily). This cools off the economy and thereby relieves pressure on prices. Unfortunately, the Fed’s aggressive monetary tightening (raising rates) has raised the possibility of a recession.
US Dollar Factors
A strong U.S. dollar could help ease some of the pressure off of the high prices we have right now. The year 2022 started out with import prices rising very quickly on a month to month basis.
- January, import prices rose 2.0%
- February, import prices rose 2.0%
- March, import prices rose 3.0%
These import prices were running hotter than the CPI (Consumer Price Index) over that same time-period. As the dollar has rallied in recent months, import prices have also cooled.
- June, import process rose only 0.2%, (smallest increase in six months)
Money Supply Factors
Lastly, the money supply which was growing at an unsustainable rate in 2020-2021 (+12% to +25% year vs. 6% year since 1995). M2 growth (a measure of the money supply that includes cash, checking deposits, and easily-convertible near money) has been about 1% for the past 6 month. This would suggest a strong likelihood that we will continue to see Core CPI inflation decelerate in coming months. The Fed may not have to increase rates as much as expected if inflation slows down faster than anticipated.
How is this different from the 1970’s
The current episode of Fed tightening that we are living through is fundamentally different from all the others. Why? The excess money creation that fueled the surge in inflation over the past year was a one-off event that was tied directly to the trillions of dollars of fiscal “stimulus” that our politicians pumped into the economy in the wake of the COVID lockdowns. Two years ago, the renowned economist Scott Grannis said “The shutdown of the US economy will prove to be the most expensive self-inflicted injury in the history of mankind.” He was proven true. Not only was the shutdown of the US economy pointless (as respiratory viruses cannot be contained by any known means), it was extraordinarily expensive since it thoroughly disrupted the world’s major economy and was indirectly responsible for a worldwide surge in inflation whose consequences will be felt for many more months to come.
We Expect the Fed to Pivot to Cutting Interest Rates in 2023
Preston Caldwell, Head of U.S. Economics for Morningstar expects the Fed to reverse course to easing monetary policy in 2023 as inflation falls back to the central bank’s 2% target along with the need to shore up economic growth. He projects the federal-funds rate to fall from a peak 3% – 3.5% at the start of 2023 to 1.5% by 2024. along with that, longer-term yields—including mortgage rates— should fall as well.
Falling inflation should clear the way for the Fed to cut interest rates. He is projecting price pressures to swing from inflationary to deflationary by 2023, owing greatly to the unwinding of price spikes caused by supply constraints in durables, energy, and other areas. He projects inflation to average just 1.5% over 2023 through 2026.
Tips for Back-to-School Shopping
Many of you have kids at home and are about to face… Back to School! Like me, you are looking for value everywhere, and let’s face it, this year we need all the value we can find!
No matter your list, a bit of prioritizing, budgeting, and thoughtfulness will stretch your dollars far and wide. Here are some ideas to help you do that!
- Create your list and put it in order by importance. Chances are, some of your items can be purchased next month. Or even the month after that.
- Decide on your budget. Whatever you’ve allocated to spend… go ahead, but be careful to stick to your plan!
- Before you shop for clothes and shoes, take an inventory of what still works. Purchase some things now, then more next month. Don’t worry – there will be more sales. Stretch the purchases over a few months to help alleviate the pinch.
- Don’t bypass the dollar stores. While some things like Crayola crayons can’t be substituted (in my opinion!) … there are certainly other great finds at excellent prices at your local discount store.
- Take advantage of your states tax free weekend! Both GA and NC have theirs this weekend and SC’s is on August 5-7.
- Clip your savings from the paper or in digital couponing sites like Honey or Dosh.
- Download apps to stores too. Many times, there are deals and coupons waiting for you.
Taking time to plan, will alleviate much of the stress that can surround “Back to School,” and will help you have peace of mind.
Please know, MFG hopes your kids have a great 2022-2023 school year. May they have fond memories of this year… for many years to come!
Why Continue to Invest in Today’s Market (or Why Start Now)?
Everyone begins their investment journey at different stages in life, however, we can all agree that the sooner you start, the better your portfolio will be in 10, 20, or even 30 years. This equates to a better life in retirement.
But why invest now, when the market is down so much, and there could possibly be a recession soon? The simplest answer is the longstanding “buy low, sell high” adage. If Shane, who recently paid off his student loans, has no other debt besides his mortgage, decides to invest during a bear market (a market experiencing prolonged price declines) and that bear turns to a bull market — which traditionally has taken 289 days, or nine and a half months (Avery, 2022) there would be no complaints from Shane as he watches his portfolio grow with or without contributions.
What happens if Shane invests his money, and that bear market continues its volatile ways and turns into a recession while he keeps investing? When should he buy, how will he know when is the best time to put money into the market?
Well, that is where dollar cost averaging comes into play, which is investing a fixed dollar amount on a regular basis (monthly is typical), which benefits the investor in a multitude of ways, including establishing healthy investment habits, minimizing market regrets, minimizing the effects of market volatility, and reducing missed opportunities (Hayes, 2022). The two charts below show how investing the same amount of money monthly increases share totals due to the fluctuating prices of the market, increasing Shane’s holdings by 35%.
So what is the difference? Utilizing the dollar cost averaging system Shane was able to obtain 35% more shares, meaning a larger portfolio value as the share prices increase.
No one knows when the optimal time to invest is (unless you are looking at the market historically), but the United States Stock Market has always rebounded (after all, the stock market is merely a reflection of businesses / companies), and the current market should be no different from the past unless it does something it has never done before.
- Avery, D. (2022, June 25). Bear market: How long will stocks fall and could it cause a recession? https://www.cnet.com/personal-finance/bear-market-how-long-will-stocks-fall-and-could-it-cause-a-recession/#:~:text=How%20long%20does%20a%20bear,about%20nine%20and%20half%20months.
- Hayes, A. (2022, May 28). Understanding dollar-cost averaging (DCA). https://www.investopedia.com/terms/d/dollarcostaveraging.asp
- Miller, S. (2022). 2022 Coin and Arrow Picture. SHRM. https://www.shrm.org/resourcesandtools/hr-topics/compensation/pages/inflation-rate-hits-7-percent-year-over-year-driving-real-wages-down.aspx.